Module 5

What is unsystematic risk?

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Qualitative analysis

Qualitative analysis

So far, we have covered the quantitative element of fundamental analysis and will now discuss the qualitative perspective. With investing, statistical information is dominant but it doesn’t provide a full picture of a business.

Qualitative fundamentals are more subjective and are not always as easy to use.

Examples include the appropriateness of business model chosen by the company, the quality of the management, the competitiveness of the business and the relationships that company has with a variety of stakeholders (i.e. the general public, suppliers or the government).

Combined with quantitative fundamentals, qualitative analysis helps an investor to develop a better understanding of a business. This understanding ensures that they are fully informed about a company before deciding to invest.

Human capital and brand equity

Human capital refers to the ability of a firm to effectively hire and retain individuals or collective employees, that add significant value to the company.

More specifically, human capital includes the educational background, intelligence, skills, and health of the employee, as well as their training, loyalty, and punctuality. All of which increase productivity and lead to higher profits.

Key ways to measure how well a company deals with human capital is staff turnover as well as to assess the quality of individuals that they hire. If staff turnover is high or the quality of employees is low, it suggests that staff are not satisfied, leading to higher costs for the business and lower productivity.

An investor may observe the turnover of staff at a particular business in person or enquire about potential job openings over a period of time. In addition, the quality of employees can be observed through the requirements outlined in job listings.

Brand equity refers to the power of a company’s brand. It is an important aspect of business as brand associations and customer or investor loyalty add or subtract from the value of a firm. 

Customers are willing to pay a premium to do business with a brand that they value and respect, which allows the company to make a larger profit – which is a positive thing for shareholders. 

To measure brand equity, investors can observe how the general public react to the new products that a company releases onto the market. If there is a strong desire for the general public to purchase the product, then the business has strong brand equity.

A good example would be how the general public public react to Apple and the iPhone (i.e. people willing stand outside of their local Apple store for days).

Economic moats and corporate governance

An economic moat refers to a companies ability to maintain competitive advantages over its competitors. They allow a company to protect its long-term profits and market share from competing firms.

The idea of an economic moat comes from the moats used by medieval castles, to protect their resources from outside forces. Economic moats play a role in making investments attractive.

Companies can have an economic moat in various ways. The most obvious ways are to be larger than competitors or to have a cost advantage which allows you to produce products at a cheaper price.

Other ways include that a company has exclusivity agreements with key suppliers or customers, ownership over a key patent or license, strong brand equity or being able to attract superior human capital.

So, an investor can identify whether a company has an economic moat or not by observing how a product performs in comparison to other products in the same category.

If a company has an economic moat, they tend to dominate in their particular area and form agreements that place them in front of the most consumers.

A good example of this would be Coca-cola, which is by far the most popular soft drink brand. One observation is that Coca-Cola has a partnership with McDonald’s that ensures that it is the most popular drink in the most visited fast food restaurant.

Corporate governance refers to how a company balances the interests of many stakeholders. This would include shareholders, employees, the general public and the government.

Evaluating the corporate governance of a company is fairly easy, you simply need to observe how the company treats their stakeholders and how they react when something goes wrong.

Ideally, when something goes wrong, it is desirable for a company to react quickly to fix the issue or to apologise, in order to maintain trust. If a company does not do this, it can have a significant impact on profitability of the company.

The best way to examine the corporate governance practices of a company is to simply read news about the company or to listen to interviews with key employees.

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